The dollar must be replaced – yet again

On music and art

Things have been so busy that I haven’t been posting as much as I would like. Besides my increased writing commitments and the constant barrage of news, I would like to mention that over the past weekend we completed the second annual festival of experimental and avant garde music, featuring the best Chinese composers and performers from all over the country, and several of my regular blog readers attended – thanks for that, even though this blog is no longer available inside the Chinese firewall.

Twenty hours of music over two days is not always easy, especially when some of the music is “challenging,” to say the least, but I am pleased to say that this festival has become the premier event in China for new and experimental music and the turnout was larger than expected and very enthusiastic. So far we don’t seem to have been affected by the economic crisis. In particular performances by Mamur, Li Jiahong and Li Tieqiao, Shouwang’s White Ensemble and a number of others were exceptionally good. We’re all still exhausted, but already I have been getting urgent enquires about our plans for next year.

While on the subject of art I should note that the People’s Daily had an article today on difficulties facing the Chinese art market.

The global economic meltdown has hit the city’s art exhibition industry, with several big international events attracting less funds than before or even being postponed, exhibition organizers said.

The article goes on to discuss difficulties facing the 798 Art District in Beijing “a center featuring primarily non-government-funded art events, where many shows were cancelled.”

I am not totally sympathetic because it seems to me that the commercial art scene here was simply part of the late stage credit bubble, and the young artists I like best were never really able to participate. But it is a nonetheless interesting story because historically art bubbles have always been part of the bubble cycle.

On that topic, I thought I would make a quick, and perhaps a little snide, reference to an article in last month’s New York Times about the Chinese art market. About a year ago I had dinner with a group of people which included a couple of gallery owners specializing in contemporary Chinese art. Not surprisingly, they were ebullient about the seemingly inexorable rise of Chinese contemporary art prices, and perhaps also not surprisingly, I was enough of a wet blanket to argue that we were soon going to see a total collapse in art prices.

Why? Because every serious financial bubble in history was, towards its later stages, accompanied with an even more ferocious bubble in art prices, and when the bubble burst, art prices were among those worst hit (I refrained from adding that although there are a number of young Chinese underground artists whose works I really love – stand up, Cult Youth Collective – for the most part I was very unimpressed with the commercial stuff getting most of the attention).

Needless to say most of the dinner guests were politely skeptical, and my pointing out the examples of the Japanese art market in the 1980s and the Arab art market in the 1970s – two markets that people don’t talk about much anymore, it seems – didn’t make much difference. One month later I read in one of the British newspapers that some well-known London-based art dealer had announced that prices in the art market had reached a level that represented long-term artistic value, and would not be affected by the crisis (art prices have reached a stable plateau? I hope he was otherwise as good an art dealer as Irving Fisher was an economist).

So what does the New York Times article say?

A global financial crisis has wiped out vast amounts of personal wealth, prompting a plunge in art prices. Suddenly bereft of visitors, galleries are laying off staff members, and the collectors who patronized them now worry that their art investments may prove a colossal folly. “It’s been a long, cold winter,” said Zoe Butt, director of international programs at Long March Space, which is closing two of its three Beijing galleries. “The era of Chinese contemporary art commanding such high prices is over.”

…Globally, the recent rise in Chinese artists’ fortunes was unparalleled. Only one Chinese artist — Zao Wouki, a traditional painter who lives in France — ranked among the Top 10 best-selling living artists in 2004, according to, which tracks auction sales. (He ranked ninth.) But by 2007, 5 of the 10 best-selling living artists at auction were Chinese-born, led by Zhang Xiaogang, who trailed only Gerhard Richter and Damien Hirst. That year, Mr. Zhang’s auction sales totaled $56 million, according to Many collectors were seduced by the numbers. “For people who got into the market three years ago, I feel sorry for them,” said Fabien Fryns, who runs F2 Gallery in Beijing.

When people say that it isn’t easy to know if we were in the midst of a bubble, I can only respond that when, in just three years, the number of Chinese artists in the top ten living best-sellers zooms from one to five, it must be obvious that we are in a particularly frothy bubble. No matter how rapidly talent and access to collectors improve, the quality of an art scene simply cannot adjust at anywhere near that speed. I am sure even Renaissance Florence under Cosimo de Medici’s very wise patronage took much longer than three years to move so far up the artist-income scale.

A new reserve currency

But back to less exalted things. The number one topic of conversation right not seems to be an essay posted in both English and Chinese on the PBoC’s website by PBoC Governor Zhou Xiaochuan. In it Governor Zhou argues that the world needs a new and better reserve currency, one not dominated by a single country, and that it is in the best interest of the world that this reserve currency be created by a body like the IMF. Funnily enough for all the attention the essay received I saw no mention of it on either Xinhua or the People’s Daily.

We have heard these kinds of arguments many times before over the course of the 20th century, and usually in response to a global balance of payments crisis. Is there anything new about this proposal? Some commentators saw this essay as a purely political move. Jamil Anderlini of the Financial Times, for example, had this to report:

China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund. In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.

Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China. “This is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money,” said Qu Hongbin, chief China economist for HSBC.

Although Mr Zhou did not mention the US dollar, the essay gave a pointed critique of the current dollar-dominated monetary system.

Others were more intrigued by the theoretical implications of the essay. A number of people including Columbia University’s Joseph Stiglitz, are supportive of the idea, arguing that the status of the US dollar as the world’s reserve currency creates unnecessary problems for both the US and the rest of the world.

Most importantly for the US it means that it is very difficult for the Fed to manage domestic monetary policy because the US financial system must accommodate not only conditions in the US but also distortions introduced by the use of the US dollar as a reserve currency, and these distortions can be massive. The most obvious example is the way over the past decade systematic industrial policies mainly in China and East Asia aimed at running trade surpluses and the accumulation of reserves meant that the US economy and its financial and monetary systems were forced to adjust in ways that created large and serious imbalances, which only now are we resolving.

But although I think the world would be better off if there were an active alternative to the US dollar, I can’t help but think all this flurry of talk is a waste of time and driven mainly by political considerations almost wholly divorced from any understanding of exactly what a reserve currency is and how its status is achieved. Every decade or so there are calls for the replacement of the US dollar with a more international reserve “currency” but they always lead exactly nowhere, and I can’t think of any reason why this time will be different. On the contrary, one of my working assumptions is that with the end of the global liquidity cycle the value of liquidity will be higher than ever. New currencies and currency unions thrive during the liquidity cycle. They almost never survive the end of the cycle.

Perhaps Governor Zhou has much more faith than I do in the role policymakers have in creating reserve status – as if you could fill a few boxes, make a political decision, and then simply create a new, widely used reserve currency. But the fact is that excessive reliance on the US dollar was not a policy decision. If the world truly wants a more “balanced” reserve currency system there are, after all, many currencies that could have functioned alongside the US dollar, but investors, central banks, and international traders seem to have had little interest in acquiring a “balanced” portfolio of reserve currencies.

For one thing liquidity is key, and I think not even the euro – and certainly not SDRs or alternatives to the SDR – can ever hope to achieve anything like the level of liquidity implicit in the US dollar market. For another thing, for a currency to achieve reserve status there must be some systematic way of delivering the currency to central banks and other players who want to acquire it, and the US does so by its ability and willingness to run persistent trade deficits. How will the IMF or whoever controls the SDR create and assign reserves?

More specifically, if the SDR is indeed a true reserve currency, and not simply an accounting entry that allows central banks to pretend that they are not holding dollars but whose value ultimately rests on its convertibility to the US dollar, who will determine the global money supply and how do we prevent this from becoming a horribly politicized process? After all the Fed has an interest in seeing stability in the value and use of the dollar, and so it can be counted on more or less to act in the best interest of the reserve currency, but why should anyone care about the value of the SDR over the long term and, more importantly, how can prudent behavior be enforced? More worryingly, if Europe has had so much trouble managing monetary policy among a group of neighboring countries with fairly similar social and economic conditions, how do we manage monetary policy on a global scale?

Perhaps the SDR is a covert way of getting back to something resembling the gold standard by creating a fiat currency with very strict rules about its expansion. If that is the case, the SDR almost certainly won’t last long. Since we’ve gone off the gold standard we have forgotten how brutal and unforgiving gold-standard discipline can be, and I think it was Barry Eichengreem who argued in Golden Fetters that the gold standard could only work in a society in which the poor and the weak have little political power, the voting franchise is limited, and the impact of monetary policies on underlying economic conditions was not widely understood.


All this talk of new currencies and new financial architecture is obviously aimed at the upcoming G20 meetings. I very much doubt anything useful will come of the meeting except for diplomatically restrained name-calling, and I am currently writing a piece to be published by the Carnegie Endowment (who I recently joined), which I hope to have by the end of this week, discussing some of the issues the participants are going to face.

Bu away from the world of high finance I thought I would mention two things. The first is an article in last week’s Xinhua on hiring prospects.

The latest report by major job service provider Manpower indicates that hiring prospects in China may continue to drop by a “considerable 10 percent” in the second quarter as the global financial crisis began to affect the real economy. The report, based on a survey which covered 4,149 employers across the country, showed that the eastern job markets were experiencing the weakest hiring climate in four years.

The next article, on the same topic, is from today’s People’s Daily. It focuses specifically on the job outlook for college graduates. Last week I read an article – also in People’s Daily, I think, but I can no longer find it – in which it was claimed that the share of Guangdong students graduating in 2009 who already have job offers was less than half of the share last year at this time. Today’s article seems to confirm this:

In an unfortunate reversal of fortune, more than 70 percent of upcoming graduates have yet to secure a job. “Normally about 70 percent of graduates have job offers in March, but now the situation is completely upside down,” Wu Xiaohui, senior campus recruitment consultant with Shanghai Foreign Service Co Ltd (SFSC), told China Daily yesterday.

The article goes on to say:

According to another survey by SFSC, about 55 percent of the city’s 104 multinational corporations didn’t intend to recruit new staff this year amid the deepening recession. Among those who plan to hire, half will recruit fewer than 10 people, compared with an average of 50 to 100 people in previous years.

Along with this gloomy outlook the World Bank last week cut its growth forecast for China. When they cut their forecast last year, I said they would revise it downward at least one more time. Perhaps this time will be the last downwards revision for 2009, but if it is, expect a series of downward revisions for 2010. This is from last week’s Xinhua:

The World Bank (WB) has cut its forecast for China’s 2009 economic growth yet again — this time to 6.5 percent from 7.5 percent, it said here Wednesday. This is the second cut the bank has made for China’s 2009 gross domestic product (GDP) growth forecast. Last November its prediction stood at 9.2 percent.

This came after the bank lowered its forecast for the 2009 world economy, which was expected to decline 1.5 percent from 2008. In November, the WB forecast the world economy would grow 1 percent this year.

6 Responses to "The dollar must be replaced – yet again"

  1. devils advocate   March 24, 2009 at 1:48 pm

    thanks for observing actual on site from real people talk in Chinasince domestic Chinese demand is a key to the future world economy, is there any survey of Chinese consumer sentiment available?

  2. Anonymous   March 24, 2009 at 7:25 pm

    The Chinese demand, at first sounded like just unthinkable and greedy on the Chinese side. However, as a global traveler and economy and technology savvy American professional, I know the strength of dollar and its demand in every corner of the world is not just beneficial for the US and its citizens, the dollar has a strong stabilizing effect in currency exchanges across the world. And when you consider the economy power of the US and, thank God, the world economy works on its own (not China), the true value of the US is true and current. In other words, the dollar’s buying power is dictated by the world economy and not even the US can much about it… unless to screw it up.We all know how China was manipulating its currency since, at least, 2004 to increase the purchasing power of their Yuan Renminbi; a mere 2 years after entering WTO. For every dollar the Chinese export to US, they only import $0.15 (Yes, that is just fifteen cents!). How much overhear can you add to that? What kind of net profit will you have from 15¢? They also take a grand pride in the success of their currency manipulation tactics as if it was something to be proud of. Every Chinese adult citizen craves for the yuan and all they see is RED$, which is the equivalent of GREEN$ in the rest of the world. That right there is reason enough not to accept their wish of currency change today. Especially after 2007 where they surpass US by $90 bill in import export values against US. How else could they have surpassed Japan as the #1 US trade partner. That is how we end up owing them a trillion dollar or more….The problem is a much larger issue than the Chinese demand where they care only about their Yuan. They don’t care about the cost for the rest of the world, the US, the IMF etc.If we allow China to dictate us on what to do regarding our economy and strong dollar, I know exactly what their next decree would be. Abolish your entire military arsenal improvement until the arsenals that of US and China are equal… or more equal or get ready for the consequences. I know it sounds like a joke. I wouldn’t have imagined that they will tell us what to do about our dollar values either!? Now, that is not a joke! Is it!?I just have this bad feeling that a few so called strong nations in the world are conspiring against the demise of the US in everyway they can. Just like the Russians say “Hold them and let them bleed!” as in Iraq and Afghanistan without any support from them while encouraging other nations to fight against US as in Iran, Venezuela and others.We will come out of this economic trouble and the image issues that is upon us now. However, it became a good binocular to show us who is friend and who is foe regardless of how they play their cards. And yes, they are playing their cards in many ways, blocking oil delivery, invading independence nation, encouraging rogue nations to stand against us, blaming the global economy and warming on us, belligerently discouraging the use of dollar across the globe, stealing critical data and information from our most revered institutions like pentagon and NASA etc…Hold on tight brave ones, we will again come out of this stronger.

  3. PhilT   March 24, 2009 at 8:26 pm

    Reserve Currency

  4. george harter   March 27, 2009 at 3:17 pm

    Bravo MR. Pettis,I lived on Taiwan and then the mainland for a total of 7 years. My Chinese language skills are good, not excellent. I think my cultural knowledge of all Chinese Government variants is excellent.Americans, do not understand Chinese culture. Perceptions here are Communist government political rants interpreted thru the likes of the NYT kaleidoscope and are almost science fiction. In China, ALL NORMAL people know that their government basically can do no better than lie pathologically or simply create self servng fairy tales.Some UPPERCLASS will tote the party line until cornered, pretty much everyone else…. Sure, they are P.O.’d at the US, the US government and the fact that “they don’t get no respect!” The IMF proposal is simply a bad balloon floated by the Central Government. The cadres oF REAL economists in China know it is a ridiculous proposal. I still have friends in Shanghai and I am in sporadic communication with them.They know that a transition to an IMF basket would be a global disaster, chaos would soon reign. Today they only have to bang on the US, with the IMF their leverage will be much less. WORST OF ALL, upward valuation of the YUAN would be very likely(a disaster for their exports) and the dollar would drop 10% or so also. OK, their imports would get cheaper, savings to them but actually their export markets ARE drying up and will continue to do so. Net result is very questionable, except that the Chinese will be swimming in unknown shark infested waters.Unnoticed recently is the quiet military threat China seeks to project within its MYTHICAL 200miles of territorial waters. Even though Obama is a weak man, the US Navy will probably respond on its own to the Chinese threats. Also, we, Americans, do not like to think of using THIRD WORLD tactics, but, if the US$ is relieved of its burden as a reserve currency, what is to stop future administrations from controlling debt repayments??To be impartial, why not a simple 60 day rule, any withdrawals must wait at least 60days before the government transfers funds. Hey! The hedge funds are doing it why not the Treasury. And as the Chinese are well aware it is customary in most parts of the globe to bend rules in favor of the beneficiary(the US FED). The simple “We need 30 days MORE to recheck the paperwork! Oh no, we have run out of labor hours needed to process your request etcetcetc.” Gradually, the delay becomes 120 days, 150, 180. Heck, the US government pulls that one on its own citizens!!!China knows they have nothing to gain by making international finance TOTALLY chaotic. These announcements are made to just get Geithner and Rubin and Bernanke upset. As Mr. Setser implies, what a relief to be out of that role. Ehhh, we should Be so lucky!!!

  5. Sacrifice   March 27, 2009 at 6:06 pm

    I concur with the writer’s comments.While I understand the ‘desires’ on the part of many parties to change the world’s reserve currency.I cannot imagine how practically this can be achieved within the forseeable future.I believe it is largely political bluster.“Nations have no permanent friends or allies, they only have permanent interests.”Lord Palmerston (English Statesman, 1784-1865)Martin Wolf addresses in his book “Fixing Global Finance”, that the PRC has made a central decision to constructa centralized, export-driven economy and manipulates both its currency and current accounts to this end.The current situation vis-a-vis the USA is a product of just this economic manipulation.This is not a durable solution to the problems of economic development, peace and prosperityin the PRC. It will be very interesting to see how this plays out over the next few decades.NLC

  6. Sacrifice   March 27, 2009 at 6:06 pm

    I concur with the writer’s comments.While I understand the ‘desires’ on the part of many parties to change the world’s reserve currency.I cannot imagine how practically this can be achieved within the forseeable future.I believe it is largely political bluster.“Nations have no permanent friends or allies, they only have permanent interests.”Lord Palmerston (English Statesman, 1784-1865)Martin Wolf addresses in his book “Fixing Global Finance”, that the PRC has made a central decision to constructa centralized, export-driven economy and manipulates both its currency and current accounts to this end.The current situation vis-a-vis the USA is a product of just this economic manipulation.This is not a durable solution to the problems of economic development, peace and prosperityin the PRC. It will be very interesting to see how this plays out over the next few decades.NLC